Paul J. DeNoon: In 2005, the fund rose in euro terms, outperforming its custom benchmark (33% Merrill Lynch High Yield Index, 33% JP Morgan ELMI Plus, 33% JP Morgan EMBI Global Index). Our performance was driven primarily by emerging markets, which were the best-performing fixed-income sector for the year.
Performance Review 2006
Gershon Distenfeld: In 2006, the fund ended the year modestly higher in euro terms, performing broadly in line with its custom benchmark. Country and security selection in dollar-denominated emerging-market debt contributed to performance.
Performance Review 2007
Paul J. DeNoon: The subprime mortgage crisis started in 2007, heralding challenging conditions for corporate bond managers as investors began to move out of risk assets into safe havens such as government bonds. The fund experienced a loss in euro terms, performing roughly in line with its custom benchmark. Security selection in high-yield corporate bonds detracted somewhat from relative returns, while an overweight in higher-rated financial paper also had a negative impact on performance.
Performance Review 2008
Gershon Distenfeld: The subprime crisis escalated into a broader global credit crisis in 2008, driving a flight to quality and shedding of risk, sending credit spreads to levels not witnessed since the inception of the global high yield markets. The fund declined in euro terms, underperforming its benchmark*. While the fund´s performance was not driven by direct exposure to subprime securities, its exposure to high yield corporate credit and emerging markets resulted in volatile performance.
*In 2008 the custom benchmark changed to 33% Lehman Brothers High Yield 2% Constrained / 33% JP Morgan GBI-EM / 33% JP Morgan EMBI Global Index.
Performance Review 2009
Paul J. DeNoon: Coordinated monetary and fiscal stimulus measures by global economic policymakers set the stage for a sharp rebound in investor risk appetite in 2009. Following the massive credit sell off of the previous 18 months, we believed we were seeing unprecedented opportunities in corporate bonds and we took advantage of numerous opportunities early on. The subsequent rally in credit helped the fund to rise significantly in euro terms and outperform its custom benchmark. Returns were helped in part by commercial mortgage-backed securities, which generated very strong excess returns.
Performance Review 2010
Gershon Distenfeld: Although the market’s secular recovery remained largely intact in 2010, supported by resilient emerging-market economies, the European sovereign debt crisis and concerns about a double-dip recession in the developed economies triggered several bouts of risk aversion among investors. The fund rose in euros, outperforming its benchmark. The portfolio’s strong performance was driven in part by the decision to overweight high-yield corporate debt relative to emerging-market bonds.
Performance since 2005
Paul J. DeNoon: Since the beginning of 2005, our portfolio has outperformed its custom benchmark in euro terms. It came under pressure in 2008 due to a spike in investor anxiety in the midst of the credit crisis, but our research-driven investment approach has helped the fund’s performance recover in 2009 and maintain its edge in 2010.
Investment Process and Strategy – How does the Fund Manager Invest?
Gershon Distenfeld: We believe that inefficiencies in the global debt markets arise from investor emotion, market complexity and conflicting investment agendas, and that the resultant mispricings in securities and sectors are the biggest potential source of added value for our clients. We use quantitative and fundamental research to identify and exploit these inefficiencies, as we believe this combination provides higher and more reliable alpha than either discipline can provide separately. Quantitative and fundamental Research exploit different, yet complementary, opportunities founded in investor behavior.
Our Global High Yield portfolio seeks to produce high current income as well as overall total return by investing primarily in a portfolio of high-yield debt securities of issuers located throughout the world, including developed and emerging countries. The portfolio invests in both US dollar and non-US dollar-denominated securities.
Our Global High Yield portfolio is part of an integrated global research and portfolio management platform, with portfolio managers and research analysts around the world, covering every major sector of the global fixed income market place.
We follow a disciplined, three-step investment process.
1. Research: The first stage is where our research teams develop their views and forecasts. Our quantitative research team develops expected return forecasts for countries, yield curves, securities, and currencies, identifying those that appear most/least attractive from a purely quantitative standpoint. Concurrently and independently, our fundamental research teams (economics, credit and structured assets) are performing their own in-depth fundamental research, and developing their own forward-looking expected returns, which either confirm or refute the quantitatively derived findings.
2. All forecasts are debated and vetted at formal “research review” sessions: Once each set of research forecasts has been made, our most senior research, portfolio management and trading professionals meet in formal monthly “research review” sessions, which are held or each sector of the market—interest rates & currencies, credit, securitizations, emerging-market debt and municipals. During these meetings, the research review team assesses, compares, and contrasts the quantitative and fundamental forecasts that each research team has separately generated. Crucial to this process is an in-depth analysis of the specific drivers behind each quantitative and fundamental forecast. These are discussed and vigorously debated, to fully understand the forecast as well as to determine the level of conviction in each forecast. Not surprisingly, the majority of each research review meeting each month is spent on those sectors and yield curves where our quantitative and fundamental views and forecasts differ.
3. Portfolio Construction: The outcome of each research review session is a set of portfolio themes to be implemented in portfolio construction. The portfolio management team then translates these themes into specific portfolio risk target and positioning. The team budgets risk across countries, yield curves, securities, and currencies. When we have dual advocacy for a forecast from both the quantitative and fundamental standpoints, we have higher conviction in that forecast and therefore will typically take larger positions in the related country, security, or currency. Similarly, if our fundamental forecast differs meaningfully from our quantitative forecast, our allocation of portfolio risk to that country, security or currency will likely be lower as a result.
Investment Outlook
Paul J. DeNoon: From a fundamental perspective, we think the 2011 outlook for credit across the rating spectrum is positive, because earnings are improving and companies are not prepared to damage their balance sheets. We are more positive than the rating agencies, and less concerned than the consensus, about LBO and default risk, and consequently we still think credit offers good value.
We expect to see continued global economic recovery, and we generally expect earnings announcements in 2011 to continue to beat expectations, which should be supportive of corporate prices. We expect leveraged buyout activity to remain subdued given scarcity of funding, investor caution about highly leveraged assets and the fact that many private equity funds are currently under water.
The European financial system remains a concern. European corporates are overly reliant on bank financing and are much more leveraged than their US peers. The banks themselves are in deleveraging mode and over the course of this decade this will force many more corporates into the bond market. The banks themselves are building up equity and reducing bond debt issuance. This is all happening against the strains of a monetary union under pressure. We believe that the euro area and its currency will survive the pressure, even with the potential for restructuring of sovereign debt. And we think that, overall, the European banking system is sufficiently robust to emerge without imploding.
The Portfolio is overweight high-yield corporate debt relative to emerging market bonds. We have no fundamental concerns about emerging economies (we believe emerging-market country growth will likely decelerate modestly in 2011 compared to 2010, but should still remain very healthy) but believe that current yields favor corporate debt.
Country selection is a key component in our strategy. We have defensively repositioned countries as necessary and we have avoided exposure to fundamentally weak countries to manage risk. At present, we are cautious about the volatility in peripheral European countries. We will continue to monitor each country’s specific situation closely and look to take advantage of possible opportunities.
